CHAPTER 4: MATERIAL CONTROL I y y Material cost forms a significant part (approx.

60% to 65%) of the cost of the end product. Hence, this cost needs careful planning and control which ensures: y Continuous supply of raw materials for uninterrupted production y Desired quality is maintained at reasonable cost y Investment in inventory is at minimum level i.e. unnecessary blockage of funds is avoided.

Hence, the following are some key questions pertaining to materials management: I. II. III. IV. V. I. When to order? Various levels How much to order Economic Order Quantity How much to charge pricing of materials issue How to keep a check inventory control Material losses cause and treatment WHEN TO ORDER

Timing of the purchase is important in order to achieve objectives like avoiding overstocking, ensuring that the material is ordered at right time and also avoiding shortage of materials. a. Maximum Level : A level beyond which inventory is not allowed to rise. Purpose is to avoid overstocking. It is fixed like this: Reorder level+ Reorder Quantity period) (Minimum Consumption * Minimum re-order

b. Minimum Level: Inventory is not allowed to fall beyond this limit. Purpose is to avoid shortage of raw materials. It is calculated like this: Reordering level-(Average/Normal consumption * Normal Re-order period) c. Reorder Level: This level is fixed for deciding the time of placing an order. If the stock of materials reaches this level, fresh order is placed so that by the time the material is procured, the level of material may fall up to minimum level but not below that. This level is fixed in the following manner:

ConceptAge Classes CS/ICWA Inter Cost & Management Accounting

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This quantity is called as Economic Order Quantity . This quantity can be calculated with the help of the following formula: EOQ = 2*A*O C Where. insurance. if number of orders are reduced. Carrying costs will go on increasing if the quantity of material in inventory goes on increasing. there are certain costs that are called as carrying costs. such as warehouse charges. In this situation. the first is the ordering cost and the other one is the carrying cost. breakage etc. These costs are of two types. stationery costs. the most desirable quantity to be ordered is that quantity at which both. It is fixed like this: Re-order level (Average consumption * re-order period) in order to avoid panic II. Both. ordering costs will go on increasing but as the material ordered will be in less quantity. HOW MUCH TO ORDER There are costs attached to the ordering quantity. On the other hand. The cost of carrying the inventory is the real out of pocket cost associated with having inventory on hand. the more are these costs. costs incurred for inviting quotations and tenders etc. On the other hand. If orders are more frequent. The more is the frequency of order. lighting. and another important component of carrying cost is the amount of interest lost due to the investment in the inventory. These costs include costs like handling and transportation costs. spoilage. A= Annual consumption units during the year ConceptAge Classes CS/ICWA Inter Cost & Management Accounting Page 2 . The ordering cost will come down due to reduction of number of orders. the quantity per order will increase and the carrying cost will increase. however their behavior is exactly opposite of each other. the carrying costs will decrease. Average Level: (Maximum level + Minimum Level)/2 e. Danger Level: Generally this level is kept below the minimum stock level situations like stock-out.Maximum consumption * Maximum re-order period OR Minimum level + Consumption during time lag period or lead time d. Ordering cost is the cost of placing an order. the carrying costs and the ordering costs are variable costs. the ordering costs and carrying costs will be at minimum. losses due to handling.

First-In-First-Out (FIFO) Based on the assumption that the material that was bought first will be used first in production. COST PRICE METHODS: a. e. of units purchased/issued at that price. Weighted Average Average of prices keeping in perspective the no. ConceptAge Classes CS/ICWA Inter Cost & Management Accounting Page 3 . Generally charged at actual purchase price. Simple Average Average of prices ignoring quantities. 2. Base Stock A certain minimum stock of a material is always maintained at original cost and the portion of stock above that minimum stock will be priced at any other suitable manner. Last-In-first-Out (LIFO) Based on the assumption that the material that was bought last will be used first in production. Highest-In-First-Out (HIFO) Based on the assumption that the costliest material will be used first in production generally used in monopoly products or cost-plus contracts. a week etc & not every time the material is received. c. Periodic Simple Average Simple average for a specific period such as a month. c. There is a need for these methods as the same type of material may have been purchased in different lots. d.O= Cost of placing an order C = carrying cost per unit per annum III. at different prices: 1. at different times. b. Specified Price For pricing materials which can be identified with any specific job. HOW MUCH TO CHARGE? PRICING OF MATERIAL ISSUES The following are the various methods which can help in determining the price of the material issued to the production department from stores department. b. AVERAGE PRICE METHODS: a.

d. A. a week etc & not every time the material is received. Inflated Price Includes carrying costs. c. Moving Simple Average Moving Simple average for more than one specific periods such as for 2 monts. 3 weeks etc. 3. of such periods. e. the following methods are used. losses due to evaporation etc. 3 weeks etc. f. It s the cost of the same type of materials in the market at any given time. of such periods. HOW TO KEEP A CHECK: METHODS OF INVENTORY CONTROL Inventory Control: it is essential to take care of the material lying in the stock. Moving Weighted Average Moving Weighted average for more than one specific periods such as for 2 monts. Calculated by dividing the total of periodic weighted average of each such period by no. they should be periodically verified with the physical stock so that chances of errors and frauds are minimized. Periodic Weighted Average Weighted average for a specific period such as a month. Market Price Priced at replacement price. Standard Price Price determined through a certain predetermined technical standard. Perpetual Inventory System: Perpetual Inventory system means continuous stock taking. Even though records are maintained in the stores regarding the receipts and issues. Under this system. Aims to recover full costs of materials purchased. Difference between standard and actual is transferred to the purchase price variance account. Entries in the Bin Card and the Stores Ledger are made after every receipt and issue and the balance is reconciled ConceptAge Classes CS/ICWA Inter Cost & Management Accounting Page 4 . Calculated by dividing the total of periodic simple average of each such period by no. NOTIONAL PRICE METHODS: a. b. a continuous record of receipt and issue of materials is maintained by the stores department and the information about the stock of materials is always available. IV. For inventory control.

V stands for vital items and their stock analysis requires more attention. the items of inventory are classified according to the value of usage. to the production department. There should not be any need of storing the material. Material purchased from supplier should directly go the assembly line. about 65-75% of the total quantity but the value may be about 5% of the total usage value of the inventory. E means essential items. pilferage etc are avoided. The storing cost can be saved to a great extent by using this technique. Care must be taken to see that they are always in stock. The principle to be followed is that the high value items should be controlled more carefully while items having small value though large in numbers can be controlled periodically. i. y The stores function is eliminated and hence there is a considerable saving in the stores cost. y Inventory carrying costs are eliminated totally. y Losses due to breakage. Thus these items are required to be stored adequately to ensure smooth operation of the plant. y Cost effective production or operation of correct services is possible. The reason is that if these items are not available. C. Just in Time Inventory: This is the latest trend in inventory management. the resulting stock outs will cause heavy losses due to stoppage of production.e. The main advantage of this system is that it avoids disruptions in the production caused by periodic stock taking.on regular basis with the physical stock. VED Analysis: This analysis divides items into three categories in the descending order of their criticality as follows. This principle envisages that there should not be any intermediate stage like storekeeping. Materials are classified as A. Items in class A constitute the most important class of inventories so far as the proportion in the total value of inventory is concerned. The benefits of Just in time system are as follows: y Right quantities are purchased or produced at right time. B. ConceptAge Classes CS/ICWA Inter Cost & Management Accounting Page 5 . D. Items in class B constitute intermediate position. Such items are considered essential for efficient running but without these items. B and C according to their value. These items may be about 20-25% of the total items while the usage value may be about 15% of the total value. wastage. The A items constitute roughly about 5-10% of the total items while its value may be about 80% of the total value of the inventory. Items in class C are the most negligible in value. ABC System: In this technique. the system will not fail.

In cost accounting. which do not affect production immediately but availability of these items will lead to more efficiency and less fatigue. Stock of fast moving items must be observed constantly and replenishment orders be placed in time to avoid stock out position. Thus VED analysis can be very useful to capital intensive process industries. The cost of the abnormal wastage is not charged to the production. In other words. FSND Analysis: Age of the inventory indicates the duration of inventory in the organization. This analysis divides the items of inventory into four categories in the descending order of their usage rate as follows. Waste: . 2. E. MATERIAL LOSSES Material Losses: One of the main reason of rising material costs is the loss of material in the production process. The treatment of scrap in cost accounts is normally as per the following details: ConceptAge Classes CS/ICWA Inter Cost & Management Accounting Page 6 . y N means normal moving items and such items are exhausted over a period of time. but it is written off to the Costing Profit and Loss Account. These items must be reviewed carefully before eliminating them. say one year. Scrap: . The material losses can be categorized as given below: 1. y D stands for dead stock which means that there will not be any further demand for the same.Scrap is a residual material resulting from a manufacturing process. Normal Wastage: . shrinkage. y S indicates slow moving items.e. It is of paramount importance that there should be rigid control over the material losses failing which it will be very difficult to keep the material costs in check. It is inherent in any production process.Any wastage over and above the normal wastage is the abnormal wastage. Abnormal Wastage: . unrecoverable residue etc.This wastage is such that it cannot be avoided. should be eliminated. i. The normal wastage is normally estimated in advance and included in the material cost.D stands for desirable items.Waste is a loss of material either in stores or in production due to reasons like evaporation. y F stands for fast moving items and stocks of such items are consumed in a short span of time. As it analyses items based on their importance and it can be used for those special raw materials which are difficult to procure. existing stock of which would last for two years or so. the good units should bear the cost of normal wastage. It has a recovery value and is measurable. It is necessary to identify these items and if there cannot be any alternative use for the same. It shows the moving position of inventory during the year. the wastage is divided into the following categories. chemical reaction. Wastages may be visible or invisible. In other words it is more than the standard wastage. The order levels and quantities for such items should be on the basis of a new estimate of future demand to minimize the risks of a surplus stock. V.

The accounting treatment of spoilage is as follows: The cost of normal spoilage is spread over to the good production by charging either to the specific production order or to the product overheads. If it cannot be identified. Rectification can be done at a cost which may not be economic.*********** ------------------------------------------------- ConceptAge Classes CS/ICWA Inter Cost & Management Accounting Page 7 .Spoilage:. ---------------------------------------------------. it is charged to factory overheads. Cost of abnormal defectives is charged to the Costing Profit and Loss Account.The defectives are part of production units which do not confirm to the standards of quality but can be rectified with additional application of materials.If the value of scrap is negligible. If the value of scrap is considerable and identifiable with the process or job. the good units should bear the cost of scrap and any income collected will be treated as other income. labor and/or processing and made it into saleable condition either as firsts or seconds depending upon the characteristics of the product. the cost of scrap will be transferred to job account and any realization from sale of such scrap will be credited to the job or process account and any unrecovered balance in the scrap account will be transferred to the Costing Profit and Loss Account. the amount will be transferred to factory overhead account after deducting the selling cost. The accounting treatment of defectives is the same like that of spoilage. If scrap value is quite substantial and it is not identifiable with a particular job or process.Spoilage is the production that fails to meet quality or dimensional requirements and so much damaged in manufacturing operations that they are not capable of rectification and hence has to withdraw and sold off without further processing. If the spoilage is within limits. The cost of abnormal spoilage is charged to the Costing Profit and Loss Account. it is called as normal spoilage and anything exceeding this limit is called as abnormal spoilage. This will reduce the cost of production to the extent of the scrap value. 4. The cost of normal defectives is spread over the good units and the cost of additional processing is charged to a particular department/process if it is identifiable with the same. Defectives:. 3.